A conventional annuity is the most common type of annuity contract and the one which is bought the most. It guarantees at the outset how much annuity income you will get year-to-year. This allows you to easily budget your ongoing outgoings against your income.
A conventional annuity is a good choice for a retirement option because it provides a known and secure level of income for the rest of your life in retirement. It therefore provides an income for life – an insurance against you living too long and outliving your means, some would say. You can choose to increase your annuity income at a fixed rate and help offset the effects of inflation.
However, its buying power might not keep pace with inflation, even if you opt for an increasing income, and the higher the increase you choose, the lower your starting income will be. You are locked in at interest rates prevailing today for the rest of your life. (Note that annuity rates do vary with interest rates, although this could be to your advantage when annuity rates are high).
The income taken from a conventional annuity can either continue as a level payment each month or year, or go up by a fixed amount each year. The basic annuity you can have is one that will pay you the same amount of income every year throughout your time in retirement. It never varies.
This might seem like a good idea, and most certainly level annuities will often give you the highest starting income available out of any of the retirement income products. But how do you cope with increasing prices? With inflation, the purchasing power of your annuity income will forever be decreasing. However, there are things you can do to protect your annuity income at least partially from inflation. You can choose to have guaranteed increases (‘escalation’) built into your annuity payments each year, although this will result in a reduction in your starting income, and, depending on the type of pension you have now, you may be able to choose an increase from 0.1%-8.5% a year (subject to HMRC restrictions), and this increase is guaranteed throughout your retirement. It will never fall.
A conventional annuity is the most purchased annuity contract and the one everybody gets annuity quotes for, but there are other, more flexible, retirement options available that might be better for you.